View from an International Bullion Bank
The following is the transcript of the speech delivered by Jeremy East at the LBMA Bullion Market Forum in Shanghai on 25 June, 2015.
I have been out in Asia for two years now and a lot has been happening. What I would like to do to start with is to look back over the last few years at what has been happening in China. I will then talk a little about how I think the Chinese market is evolving. We will then talk about a familiar topic: renminbi (RMB) and internationalisation, and the International Exchange. From my experience, we have seen a lot of exchanges come and develop new products. Some succeeded and some did not, and I will look at some of the challenges around that. Finally, I will cover where we are now in terms of the market, and what the future might be for China and the rest of the precious metals market.
We all know that China is the largest producer and consumer of gold. Back in 2013, something like 40% of global production was consumed in China. Last year, it was slightly less, but still over 30% was consumed in China. This year, our expectation is that this number will decline again, showing physical consumption in China declining year on year from 2013 to 2104 and from 2014 to 2015.
We have seen a mirroring of that situation with recent declining physical supplies into China, after a huge jump in shipments into China in 2013 and in the same year and a huge amount of gold supplied from the Shanghai Gold Exchange to the Chinese market. We know that the banks have been very proactive in building huge distribution networks. We have seen the jewellery companies expand their retail space. There is huge expansion in China. However, the numbers seem to be indicating that this expansion is slightly slowing. That said, however, over 2,000 tonnes were taken out of the Exchange last year.
Is this a bad thing? When I started gold trading back in the early 1980s in London, we used to trade Krugerrands – physical coins. That was the liquid market and, very quickly, we realised that we had to develop other products and other ways of being able to transact new products, so the market in London developed unallocated, forward markets and options markets, just in the same way that the Chinese market is doing today.
What we are seeing is an evolution of the Chinese market away from being primarily a physical market, towards a more directive and OTC market. The turnover on the Exchange, as we heard from our colleagues there, is growing dramatically, even though the physical supplies to the market seem to have tapered off. That, of course, is being driven, firstly, by new members of the Exchange – new international members – and also by new types of members of the Exchange – securities companies, for example – who are coming with new ideas and products. In addition, we are seeing the Exchange launch new platforms: the forward platform, the leasing platform and the recent announcement of the launch of gold options. On the back of that, we are going to see quite a change in the way the Chinese market does business.
It is not just the Gold Exchange. We have also seen this in the Futures Exchange. Over the last year or so, we have seen a dramatic increase in derivatives and futures volumes, which has not been mirrored in the international markets. For example, COMEX – traditionally, the largest precious metals exchange – has been seeing declines in volume, whereas the Shanghai Futures Exchange has seen continued growth in volume.
Everyone looks at and tries to compare India and China, which I think is not the right thing to do. They are two totally different markets. India is very much a domestic market intrinsically linked to the London market, whereas China has its own very strong domestic market and a focus to grow internationally in the global markets. In terms of the physical aspects of the two markets, it is the wrong thing to compare the India and China markets. It is rather about where these markets can go: for India, the focus is very much on a domestic market linked to London, whereas for China, the focus is on growth and internationalisation.
“The turnover on the Exchange, as we heard from our colleagues there, is growing dramatically, even though the physical supplies to the market seem to have tapered off.”
I will now say a few words about commodities. We talked a little earlier about RMB internationalisation and about gold, but gold is just one of the many commodities that China consumes. China is the largest consumer of most commodities globally; for example, crude oil, copper, gold and notably iron ore, 40% of which is imported into China. China is a huge consumer of commodities and, as we know, most of these commodities are, traditionally, priced in US dollars. Therefore, we need US dollars to trade. However, there is a movement to promote the internationalisation of the RMB, so why not start pricing the flows of these commodities in RMB? However, to do that, you need a platform. You cannot just tell the market that they have to trade gold or iron ore in RMB; there has to be a platform for them to do it.
China set up that platform in September 2013 with the launch of the Free Trade Zone in Shanghai. This enabled the free conversion, through free trade accounts (FTAs), of offshore RMB to onshore RMB. This setting up of the Free Trade Zone was really the basis to allow the exchanges to then set up platforms to price commodities. We have seen the launch of the Shanghai Gold Exchange – the International Board – last year, and we expect to see the Shanghai Futures Exchange launch a crude oil contract. I think it is planned for September this year. Again, these contracts are priced in offshore RMB, therefore promoting the internationalisation of the currency.
We as a bank have had many clients who are currently supplying commodities to China come to us looking for advice in terms of how we see the internationalisation of the RMB progressing, and also clients who traditionally trade in US dollars looking to understand what they need to do in the event that they are suddenly paid in RMB rather than US dollars. A very basic setup is required, therefore; for example, the major producing countries of the world – Africa, the United States and Canada – which are supplying commodities to China need to get themselves ready to be able to handle RMB.
“China is the largest consumer of most commodities globally; for example, crude oil, copper, gold and notably iron ore, 40% of which is imported into China.”
Shanghai Gold Exchange
As I said, the Shanghai Gold Exchange opened the doors to the International Board last year, on 18 September. A huge ceremony was held in the building where we had dinner last night. Present were the great and good of the global markets: the Governor of the People’s Bank of China (PBOC), the Mayor of Shanghai, the Deputy Governor of the PBOC, and the Chairman of the Shanghai Gold Exchange. I am not sure how I got up onto the stage, but I was there anyway, representing the international community. Now, participants internationally can trade from outside China and have the opportunity to trade onshore in China, which, again, is a new thing and we will look at some of the challenges that they have slightly later. The Gold Exchange International Board is giving a message, saying that China is now set to have a larger influence over the global pricing of commodities, especially here, in terms of gold, as well as global commodities. This is the first step on that journey.
International members of the Exchange can trade both the onshore and the offshore market. There are 11 gold contracts: three in the offshore market and eight in the onshore market. As I said, the launch of the Exchange allows international participation; however, there are challenges around starting a new contract. It is interesting to note that, when the London Metal Exchange launched the aluminium contract back in the early 80s, aluminium did not trade for a year. Now, it is the largest contract on the London Metal Exchange. Even well-known, huge exchanges launching new contracts can struggle to develop new products; however, now, with the perseverance and the engagement of the market, as I said, the aluminium contract is the largest traded contract on the London Metal Exchange.
In the context of the International Board and the new contracts, the Shanghai Gold Exchange International Board has been very successful. Daily turnover is somewhere in the region of 10 to 15 tonnes. Compared to other exchanges that have recently launched gold contracts, the Gold Exchange is by far the most successful. However, it is challenging, because it needs to attract the participation of the international community.
“It is interesting to note that, when the London Metal Exchange launched the aluminium contract back in the early 80s, aluminium did not trade for a year.”
Going back into history again, before I started in the market, London was built on the London Gold Fix and on the pricing of South African gold. Being able to supply a benchmark then was a key, fundamental building block of the London market. That really was the driver for the development of the market. What we will see here, as we heard earlier today, is that the launch of a benchmark in China will be a fundamental building block for the Chinese market. That needs to happen, as we see China pricing gold internationally.
There are barriers to entry, and we all know from the banks that there is a huge amount of money that needs to be spent on technology to link in with the exchanges. However, I expect that as time progresses, we will see more and more banks and brokers connecting with the Exchange. Business that in the past may have been executed in the US or in London has the ability to be executed in China. I would not say that this is business that is mutually exclusive, and I do not think that there is a competition – I think it is mutually enhancing. Therefore, the Shanghai Gold Exchange is moving in the right track.
“In Hong Kong, we have the huge success of Stock Connect, and I can see the future of the Shanghai International Board as really being seen as the connection between the onshore and the offshore markets.”
Where We Are Now
I would just like to finish with where I think we are now. I am suggesting a parallel here: Gold Connect. In Hong Kong, we have seen the huge success of Stock Connect, and I can see the future of the Shanghai International Board as really being seen as the connection between the onshore and the offshore markets. We see this link opening up wider and wider, and that should be seen in the widening context of the internationalisation of the RMB and the opening up of the domestic Chinese finance markets.
As things progress very quickly at the moment, if the currency and the financial markets continue to open up, it is not beyond the realms of recognition to believe that we can see a future merging of the International Board and the Domestic Board. We are already seeing the Gold Exchange work much more closely with the international markets. As we heard, we are seeing that many Chinese refiners are members of the Good Delivery List. We are now seeing a link between the Chinese market and the Hong Kong Gold and Silver Society. The markets in China are reaching out to the international markets.
“Who knows: in five years’ time, we may be trading on our online platforms not just gold Loco London but gold Loco Shanghai.”
It is, however, not just the markets but also the players. As we recently saw, Bank of China has become a participant in the LBMA price-setting. I think it is just a trend that we will see continue over the coming years, and I think this trend is accelerating. Who knows: in five years’ time, we may be trading on our online platforms not just gold Loco London but gold Loco Shanghai. Thank you.
Mr Jeremy East has over 25 years of experience in the metals industry and joined SCB in 2006. His responsibility covers metals trading, hedging, financing and investment solutions covering both physical and derivative products. Additionally, he built up SCB’s commodity inventory financing business. The metals trading business has presence in Shanghai, Hong Kong, Singapore, Dubai, London and New York serving its franchise client base mainly in Asia, the Middle East and Africa. SCB is Category 2 member of the LME, member of the LBMA and market making member of the LPPM and was the first international member of the Shanghai Gold Exchange. He recently relocated to be based in HK, to drive the growth of the metals business in Asia.
Before joining SCB, he was Global Head of Precious Metals at Commerzbank and also board member of Argor Heraeus – the Swiss gold refinery, where he focussed on a physical precious metals franchise in India, Turkey and in Russia and CIS.
Prior to that, he started his career with Philipp Brothers, then the largest commodity trading company in the world, where he traded base and precious metals. In 1990, he joined Salomon Brothers to run the precious metals business in London.
He is an International Advisor to the Shanghai Gold Exchange and on the Management Committee and The Membership Committee of the LBMA.